Capitalism is supposed to collapse under its own inner contradictions.
Professional stock market tipsters are notorious from specialising in predicting doom as well and they still get listened too despite terrible forecasting records.
The evidence is inconsistent with the view that the collapse of the financial system was caused only by the popping of the housing bubble (“accident”) and the herding behavior of financiers rushing to create and market increasingly complex and questionable financial products (“suicide”).
Rather, the evidence indicates that senior policymakers repeatedly designed, implemented, and maintained policies that destabilized the global financial system in the decade before the crisis. Moreover, although the major regulatory agencies were aware of the growing fragility of the financial system due to their policies, they chose not to modify those policies, suggesting that “negligent homicide” contributed to the financial system’s collapse.
The New York Times warned in 1999 that Fannie Mae was taking on so much risk that an economic downturn could trigger a “rescue similar to that of the savings and loan industry in the 1980s,” and emphasised this point again in 2003. Greenspan testified before a Senate committee in 2004 that the increasingly large and risky Fannie Mae and Freddie Mac portfolios could have enormously adverse ramifications.
You predict a financial crisis by pointing to adjustments in your share portfolio to take advantage of shorting the market and then showing how big a profit you made afterwards.
The movie The Big Short highlights that its protagonists had skin in the game. They were investing in mortgages or shorting the same in the expectation of the crash they were predicting. Much of the drama in the film is about how long their foretelling of a crash took to come true.
There were no windbags and armchair critics in The Big Short talking gloom and doom on the horizon without investing their own money to profit from their forecasts.
I had borrowed a lot of money from scratch after 2007. Greece borrowed a lot of money of its own accord from 2010. Italy always owed a lot of money. Spanish do not know all that much money considering their dire financial circumstances.
I do admire the way in which the USA has been able to have a steadily falling equilibrium unemployment rate since 1984 through thick and thin. The Great Recession had no impact on the US equilibrium unemployment rate. Not only has the largest member been able to do this, the OECD host country (red squares) has had a pretty steady natural unemployment rate too all things considered.
Many of the key issues about what modern macroeconomics has to say on global financial crises and deposit insurance are discussed in a 2010 interview with Thomas Sargent
Sargent said that two polar models of bank crises and what government lender-of-last-resort and deposit insurance do to arrest or promote them were used to understand the GFC. They are polar models because:
in the Diamond-Dybvig and Bryant model of banking runs, deposit insurance and other bailouts are purely a good thing stopping panic-induced bank runs from ever starting; and
in the Kareken and Wallace model, deposit insurance by governments and the lender-of-last-resort function of a central bank are purely a bad thing because moral hazard encourages risk taking unless there is regulation or there is proper surveillance and accurate risk-based pricing of the deposit insurance.
In the Diamond-Dybvig and Bryant model, if there is government-supplied deposit insurance, people do not initiate bank runs because they trust their deposits to be safe. There is no cost to the government for offering the deposit insurance because there are no bank runs! A major free lunch.
Tom Sargent considers that the Bryant-Diamond-Dybvig model has been very influential, in general, and among policy makers in 2008, in particular.
Governments saw Bryant-Diamond-Dybvig bank runs everywhere. The logic of this model persuaded many governments that if they could arrest the actual or potential runs by convincing creditors that their loans were insured, that could be done at little or no eventual cost to taxpayers.
In 2008, the Australian and New Zealand governments announced emergency bank deposit insurance guarantees. In Bryant-Diamond-Dybvig style bank panics, these guarantees ward off the bank run and thus should cost nothing fiscally because the deposit insurance is not called upon. These guarantees and lender of last resort function were seen as key stabilising measures. These guarantees were called upon in NZ to the tune of $2 billion.
1. The Diamond-Dybvig and Bryant model makes you sensitive to runs and optimistic about the ability of deposit insurance to cure them.
The Kareken and Wallace model’s prediction is that if a government sets up deposit insurance and doesn’t regulate bank portfolios to prevent them from taking too much risk, the government is setting the stage for a financial crisis.
The Kareken-Wallace model makes you very cautious about lender-of-last-resort facilities and very sensitive to the risk-taking activities of banks.
Kareken and Wallace called for much higher capital reserves for banks and more regulation to avoid future crises. This is not a new idea.
Sam Peltzman in the mid-1960s found that U.S. banks in the 1930s halved their capital ratios after the introduction of federal deposit insurance. FDR was initially opposed to deposit insurance because it would encourage greater risk taking by banks.
Late on Friday afternoon, Stuff posted an op-ed piece calling for the introduction of a (funded) deposit insurance scheme in New Zealand. It was written by Geof Mortlock, a former colleague of mine at the Reserve Bank, who has spent most of his career on banking risk issues, including having been heavily involved in the handling of the failure, and resulting statutory management, of DFC.
As the IMF recently reported, all European countries (advanced or emerging) and all advanced economies have deposit insurance, with the exception of San Marino, Israel and New Zealand. An increasing number of people have been calling for our politicians to rethink New Zealand’s stance in opposition to deposit insurance. I wrote about the issue myself just a couple of months ago, in response to some new material from the Reserve Bank which continues to oppose deposit insurance.
Different people emphasise different arguments in making the case for New Zealand to…
About the only time the Hollywood Left oozes with patriotism is when getting stuck into Wall Street. Hollywood must get its revenge for all those times investors did not back their film pitches, trimmed budgets and get the lion’s share of merchandising royalties and syndication profits. As Larry Ribstein explained:
American films have long presented a negative view of business…. it is not business that filmmakers dislike, but rather the control of firms by profit-maximizing capitalists… this dislike stems from filmmakers’ resentment of capitalists’ constraints on their artistic vision.
The Big Short is still a good film despite the left-wing populism, worth going to see. Its limitations in not discussing the monetary policy of The Fed or regulations that encouraged lending to high risk borrowers are justified poetic license and editing.
The film is already 120+ minutes long despite frequent resorts to breaking the fourth wall to explain technical terms, who was what and what they were doing, past and present. The Big Short is a film designed it make money at the box office, not a semester long documentary.
The Big Short is well acted, funny, insightful and still a good story despite the documentary element that was impossible to do without.
The Big Short highlights that its protagonists had skin in the game. They were investing in mortgages or shorting the same in the expectation of a crash. There were no windbags and armchair critics in The Big Short talking gloom and doom on the horizon without investing their own money to profit from their forecasts. That said, the protagonists betting on a sub-prime mortgages crash, bar two of them, were a little bit nutty.
These critics fall into the exact same trap that the Big Short was not about. The Big Short was about investors to put their money where their mouth is. The critics of the film should put their script doctoring skills where their mouths are at least of The Big Short.
The financial mess we’re still climbing out of can be laid directly at the feet of the Fed, whose misguided advocacy, under Greenspan, of a borrow-and-spend economy rather than a focus on savings and investment has created a situation where, as the title implies, money is disconnected from any underlying value.
Krugman and friends like the film because it leaves out any discussion of the main culprit behind the financial crisis, which was not Wall Street “greed” but bad monetary and credit policies from the Federal Reserve and the federal government. The movie barely hints at any exogenous factors behind the boom or bust. (This FEE report by Peter Boettke and Steven Horwitz fills in the missing information.) So the pro-regulation crowd is cheering. Viewers are given no understanding of the real causal factors and hence fill in the missing data with a feeling that banks just love ripping people off. To be sure, if you approach this movie with some knowledge of economics and monetary policy, the rest of the narrative makes sense. Of course Wall Street got it wrong, given Washington’s policies on mortgage lending!
To add to the brew, Edward Prescott points out the Great Recession can be explained through productivity shocks. Specifically, a collapse in investment and in particular investment in intangibles such as intellectual property in 2007 in anticipation of more taxes and more regulation.
V.V. Chari also points out that the extent of the financial crisis was overstated. This is because the typical firm can finance its capital expenditures from retained earnings so it was hard to see how financial market disruptions could directly affect investment.
What Chari disputed was that bank lending to non-financial corporations and individuals has declined sharply, that interbank lending is essentially non-existent; and commercial paper issuance by non-financial corporations declined sharply, and rates have risen to unprecedented levels.
John Taylor argues that we should consider macroeconomic performance since the 1960: There was a move toward more discretionary policies in the 1960s and 1970s; A move to more rules-based policies in the 1980s and 1990s; and back again toward discretion in recent years.
These policy swings are correlated with economic performance—unemployment, inflation, economic and financial stability, the frequency and depths of recessions, the length and strength of recoveries. Less predictable, more interventionist, and more fine-tuning type macroeconomic policies have caused, deepened and prolonged the current recession. Robert Hetzel puts it this way:
The alternative explanation offered here for the intensification of the recession emphasizes propagation of the original real shocks through contractionary monetary policy. The intensification of the recession followed the pattern of recessions in the stop-go period of the late 1960s and 1970s, in which the Fed introduced cyclical inertia in the funds relative to changes in economic activity.
Finn Kydlandconsiders fiscal policy to be at the heart of the slow recovery. Instead of restructuring and investing more prudently, Western countries faced with budget shortfalls will seek to increase taxes:
The U.S. economy isn’t recovering from the Great Recession of 2008-2009 with the anticipated strength.
A widespread conjecture is that this weakness can be traced to perceptions of an imminent switch to a regime of higher taxes.
The fiscal sentiment hypothesis can account for a significant fraction of the decline in investment and labor supply in the aftermath of the Great Recession, relative to their pre-recession trends.
The perceived higher taxes must fall almost exclusively on capital income. People must suspect that the tax structure that will be implemented to address large fiscal imbalances will be far from optimal.
Now imagine trying to incorporate all the above points into a film and keeping it at its current two-hour length?
Why Evolution is True is a blog written by Jerry Coyne, centered on evolution and biology but also dealing with diverse topics like politics, culture, and cats.
In Hume’s spirit, I will attempt to serve as an ambassador from my world of economics, and help in “finding topics of conversation fit for the entertainment of rational creatures.”
“We do not believe any group of men adequate enough or wise enough to operate without scrutiny or without criticism. We know that the only way to avoid error is to detect it, that the only way to detect it is to be free to inquire. We know that in secrecy error undetected will flourish and subvert”. - J Robert Oppenheimer.
Utopia, you are standing in it! 
Recent Comments